Credit Reports 101

It may not be as interesting as a biography or memoir, but your credit report tells one story of your life: the financial one.

And when you make the biggest financial decisions of your life, you’ll want to have a good one.

When you want a mortgage, auto loan or other line of credit, a good credit report will not only help get you approved but can also save you thousands of dollars in interest over the life of the loan. A credit report marred with late payments or even falsely reported information, on the other hand, will not only cost you a lot of money in interest, but can keep you from getting that loan for your dream car or home.

Credit Reports in a Nutshell

Your credit report is one factor that lenders consider when deciding whether to loan you money. As a record of your borrowing, it documents every line of credit you’ve ever had, from credit cards to mortgages, and whether or not you have made payments on time or at all.

Credit reports are distilled into a three-digit number called your credit score, which also helps lenders decide whether or not to extend credit to you. Credit scores typically range from 300 to 850, though this scale can vary depending on who developed the credit score model. Generally, a credit score of 720 is considered “good,” and will get you the best rates available on loans and credit cards. However, it’s important to remember that lenders can have different standards for what they consider to be a good credit score.

Credit reports are created and maintained by the three major credit bureaus—Equifax , Experian and TransUnion—which collect individuals’ credit information, then sell it to lenders such as credit card companies and banks. That means you have three credit reports, although they should contain the same information. The lenders you do business with will report your lines of credit and your repayment habits to the three credit bureaus. (Keep in mind that some lenders, such as smaller credit unions, may only report to one or two credit bureaus. Reporting to the bureaus costs money, and it is sometimes too expensive for smaller companies.) The bureaus will then collect that data in your credit report to create a complete snapshot of your credit health. Most people over the age of 18 have a credit report, even if their credit history is short.

Why Your Credit Report Is Important

Let’s say you want to buy a home. As you shop around for a mortgage, each lender will take a look at your credit report and score. Your credit score is kind of like a numerical grade of your credit report. That grade, along with the details of your credit report, will determine two things: Whether or not you’re approved for the loan, and what interest rate you’re offered.

If your report shows you have a long and positive credit history, lenders will be more likely to approve you for a loan and offer you low interest rates.

Term Sheet

Credit Report
n. Created and maintained by the three major credit bureaus, you credit report is a detailed account of your credit history. For each of your various credit accounts, it lists how much you owe, whether you pay on time and other details that help a lender determine how risky it is to lend to you.

Credit History
n. This is a full record of your debt repayment. It includes all of your borrowing activity on individual credit lines: how long each account has been open, what the remaining balance is, when you’ve paid on-time and when you’ve made late payments. This history will help lenders decide whether or not it’s likely that you’ll repeat your past behavior, whether positive or negative. That decision will determine your approval and your interest rates for loans and credit cards.

Credit Bureau
n. Also known as a consumer reporting agency, a credit bureau is a company that collects and stores information on individual consumers in credit reports. Financial institutions and lenders report consumer information to these bureaus, which in turn sell the information back to potential lenders.

Credit Line
n. This is any financial account that involves the borrowing of money and the paying back of debts. Credit lines include credit cards, student loans, mortgages, auto loans, home equity lines of credit and personal loans. They do not include bank accounts or savings accounts.

Think about it this way: If your credit score is your GPA, your credit report is kind of like your high school transcript, containing all of the courses you took and the grades you received. Just as your high school transcript will help determine which college you’ll attend, your credit report will help lenders predict what kind of borrower you will be and decide what loans they’ll approve you for.

But lenders aren’t the only ones who will look at your credit report. It could help or hinder you in getting a job, affect your insurance rates and help you detect identity theft. Potential employers may request permission to view your credit report before deciding to hire you. Also, companies can buy your credit information if it’s for “legitimate business needs.” For instance, insurance companies often view your credit information when determining your insurance rates since past behavior is a good indicator of future behavior.

As you can see, it just might give potential lenders an idea of how you'll handle a loan from them.

Your credit report will also, if applicable, include any negative information related to your credit. This includes debts that have been sent to collection agencies, bankruptcies, foreclosures, federal tax liens, late payments and hard credit inquiries, which occur when a lender checks your credit for a loan approval. The more serious of these negative items, such as bankruptcies and foreclosures, will severely limit your ability to get approved for a loan or line of credit. However, most of them will stop negatively affecting your credit after a period of seven to 10 years.

Lastly, your credit report also lists some personal identification information, like your name (or any past names you’ve used) and former and current addresses.

What You Should Do Now

1. Always pay your bills on time.

Want a good credit report? The best way to get one is to never miss a payment.

2. Keep your credit card balances to less than 30 percent of the credit limits.

The ratio of your balance to your credit limit is called your credit utilization rate. A rate of less than 30 percent shows lenders that you’re using your credit regularly and responsibly.

3. Hold on to your oldest accounts.

Unfortunately, those with short or no credit history (or no credit accounts) will find it more difficult to gain access to credit. That’s because lenders base their decisions on your past actions; if you have none to show, they likely won’t take the risk of lending to you. Unless they’re costing you a lot in annual fees, don’t close a credit card account once you pay the card off. Instead, keep your oldest credit card accounts open so that your credit history is as long as possible.

4. Check your credit report at least once every four months.

The Fair Credit Reporting Act (FCRA) requires each of the three credit bureaus to provide you access to one free copy of your credit report every 12 months. You must request each report; it won’t be mailed to you. You should stagger your requests throughout the year so that you receive a report from one of the three credit bureaus every four months, but you still only get one per year from each company. Use our checklist to get your credit report.

There are also a few other times when you can legally receive a free credit report, such as when a company denies you credit or employment based on your credit report, or if you become unemployed. Check out the FTC’s website for details on your rights in these instances. You can also monitor your TransUnion credit report for free with Credit Karma. Once you’re signed up, the service will email you whenever something significant changes in your credit report, like a new account or a new hard credit inquiry.

If you ever use up all your free reports in a year and want to buy one, the costs vary from bureau to bureau, and each bureau also offers several packages at different prices. Here is the cost breakdown at each: Experian, Equifax and TransUnion.

5. Comb your credit report for errors and dispute any.

Errors could reflect negatively on your credit and prevent you from getting a loan or lead to a higher interest rate on your loans. It’s been reported that as many as 25 percent of credit reports could contain serious errors. These errors can include outdated personal information (not that serious), incorrect account details (possibly serious) and mistaken or fraudulent accounts (very serious).

If you find one of these errors, dispute it by sending a letter to the credit bureau and the company reporting the incorrect information. (See our checklist for more info.)

Remember ...

The first step to making some of the biggest purchases of your life begins with understanding your credit. You must know what’s in your credit report, how to improve it and what it will be used for. If you wait to build a good credit report until you need one, it will be too late.

Make today’s goal to get a copy of your credit report; it’ll take less than five minutes, and it’s free. Once you know what’s in your credit report, you can begin improving your credit.

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LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a financial adviser for advice specific to your financial situation. LearnVest Planning Services and any third-parties listed, discussed, identified or otherwise appearing herein are separate and unaffiliated and are not responsible for each other’s products, services or policies. LearnVest, Inc. is wholly owned by NM Planning, LLC, a subsidiary of The Northwestern Mutual Life Insurance Company.